Monday, July 9, 2007

Most Prosper lenders do not diversify their portfolio

Diversifying your Propser loans allows you to lower the overall impact on your portfolio if one or more of your loans go into default. With 20 loans of equal amount you would have 5% invested in each loan. That means if one of your loans defaults you loose 5% of your investment. Lets assume you have an all AA portfolio and you are at 9.5% interest on your loans. One default would reduce your return to around 4.5%, and a second default could put you at a negative return. Increasing the number of loans to 50 so that you have 2% invested in each loan achieves better diversification. Under this scenario, after one default you would still be at around a 7.5% return, and close to 5.5% in the event of a second default. So, diversification is really helpful at reducing the overall risk on your portfolio. So, how many prosper lenders diversify their portfolio? Lets look at some stats:

Number of Lenders

Percentage of Lenders

Less than 20 loans

15769

70%

Between 20 and 50 loans

3895

17%

More than 50 loans

2863

13%

Looking at this table, less than 15% of Prosper lenders have well diversified portfolios and 70% have little or no diversification. So, why is it that Prosper lenders are not very good at diversification? Looking at some additional stats will help us answer that question.

At Prosper you are required to invest a minimum of $50 when making a bid on a Prosper loan. This means to have 20 loans you need to invest at least $1000, and to have 50 loans you need to invest a minimum of $2500. When we analyze the number of lenders by amount invested we get that 41% of lenders have less than $1000 invested. So, short of investing more money into Prosper, there is nothing that these small lenders can do to diversify their portfolio.

On the Petri Dish suggestion forums several lenders have requested that Prosper lower the bid requirements for lenders to allow them to better diversify small portfolios. Judging by the number of small lenders with no chance for diversifying their portfolios I think this would be a good idea and a welcome improvement. Zopa, a peer-to-peer lending site in Europe, allows lenders to have as little as 5 Euros invested in each loan. I think lowering the minimum bid to $10 or even $25 would be a welcome improvement.

8 comments:

Prosper was designed for retail (as opposed to institutional) lending. That's why they specifically require you to register as an individual. When the buy-in is $50, how can you not expect those retail investors to creep their way in. It's unfortunate that they'll get 4 or 5 loans, have one go bad, and get soured on the experience.

Kevin, the idea behind the article is that most lenders are unable to diversify because they have too little invested relative to the minimum bid size. That prevents them from being able to diversify. However, your point is valid. If we eliminate the ones that are unable to diversify, we could look at what percentage diversify their portfolio when enough funds are available to do so.

Here are the stats on that: 89% of people with $5000 or more invested are diversified into 20 or more loans.73% of people with $1000 or more invested are diversified into 20 or more loans.

It seems that if the opportunity is available most lenders will diversify, but since the minimum bid is so high most lenders do not have the option to properly diversify.

if you think Prosper is an investment vehicle and not a social cause - (which we should) $1000 or even $2500 minimum is not alot

Most mutual funds require a $1000-$2500 initial investment nowadays (accounts smaller than that are too expensive to maintain they claim) with additional investments usually in the range of $250-$500

There are exceptions but that is how the vast majority work. So if you want to claim Prosper as a good thing to do with your heart than hey $50 is cool. But as an investment $1000 is not a lot as a minimum.

Many (20% I think when I looked 2 months ago) of lenders are either 1 and done, or 2 and done... $50 to $100.

I also agree diversity is key but not to overdiversify. The magic # is probably between 50 (2% in each loan) and 150. Anything more than that and you basically are buying an index fund and it will be hard to outperform market averages.

While number of loans is a good measure of diversification there are other ways to diversify. Some of the lenders you identified may still not be diversified even though they have 20 or 50 loans. If all loans are to HR borrowers then they are not truly diversified.

This is why I am becoming a fan of Lending Club -- they provide tools for easy one-click portfolio diversification. The problem is that on Prosper it is DIFFICULT to diversify -- requires time and effort. Lending Club is FOCUSED on diversification.

Josh,When do you last check Prosper ? There are portfolio plans that provide automatic diversification now.I think an important point is that while the minimum bid is $50, in order to get diversification you need to put in somewhat more.